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Even Trump Is a Keynesian

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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What does the election of Donald Trump mean for macroeconomics? Above all else, it means that the half-century-long challenge to Keynesian ideas is over. The insurgents lost.

First, some background. During the Great Depression, John Maynard Keynes suggested that government spending would boost the economy, by increasing aggregate demand. In a recession, there are unused resources -- empty offices, idle factories and unemployed people sitting around at home. This obviously means an economy is producing less than it could; if someone just took the unemployed people and put them in the empty offices, output would go up.

For Keynes, that someone was the government. Handing out money, whether through tax rebates or (preferably) infrastructure projects, would prompt people to spend that money, which would prompt other people to spend the money in turn, creating a virtuous cycle. Spend enough government cash, and you could put all of society’s unused resources to work, ending a recession. This was the theory of fiscal stimulus.

This idea was embraced by many of the most prominent postwar economists in the U.S., such as Paul Samuelson and James Tobin. Politicians on both sides of the spectrum also took the idea to heart -- John F. Kennedy’s tax cuts were motivated by the desire for stimulus, and Richard Nixon famously declared in 1971 that “I am now a Keynesian.”

Beginning in the 1970s, however, there was a concerted effort to push Keynesian ideas out of the mainstream. A number of prominent up-and-coming macroeconomists declared that Keynes’ basic idea should go to the trash heap of history. Harvard’s Robert Barro, for instance, made a famous model purporting to show that tax rebates couldn’t change gross domestic product in the way Keynes thought. If the government taxed people less today, they would know that taxes would go up in the future, and so they wouldn’t change their spending patterns.

Then, in a landmark 1979 essay entitled “After Keynesian Macroeconomics,” Robert Lucas and Thomas Sargent -- who would both go on to win Nobel prizes -- wrote:

In the present decade, the U.S. economy has undergone its first major depression since the 1930s, to the accompaniment of inflation rates in excess of 10 percent...[this was] accompanied by massive government budget deficits...[which] Keynesian doctrine [says should lead to] rapid real growth and low rates of unemployment…these predictions were wildly incorrect and that the doctrine on which they were based is fundamentally flawed.

According to Lucas and Sargent, fiscal stimulus was essentially a government trick. If people and companies were rational, then there must be a good reason for factories to go idle and workers to stay at home during recessions. The only way stimulus could work is by fooling these people into producing more output than they really want to -- but since people are smart, they can’t be tricked for long. Hence, stimulus can’t work. To Sargent, Lucas and many others, the stagflation of the 1970s was all the proof that was needed.

During the next 25 years, models that included absolutely no role for stimulus became the norm. Lucas famously declared in 2003 that “the central problem of depression prevention has been solved” without any need for government spending.

But American politicians never seemed to get the message. In the early 1980s, Ronald Reagan cut taxes and dramatically increased government spending on the military. Although there were non-Keynesian reasons for both actions -- tax cuts can increase efficiency, and military spending was to counter the Soviet Union -- the whole policy package looked awfully Keynesian in nature. Later, Bill Clinton tried to fight the early 1990s recession with a fiscal stimulus package, only to see it defeated by a filibuster. George W. Bush signed a stimulus bill in 2008 that mailed checks to every American, which he labeled a “booster shot.” And of course, Barack Obama pushed through the American Recovery and Reinvestment Act in 2009 in response to the Great Recession.

Now, Donald Trump is amping up the Keynesianism. Although the numbers are fuzzy, he consistently promises large tax cuts and a lot more infrastructure spending. Though the economy isn’t in a recession, Trump seems to be betting that Keynesian policy will keep the economy -- and his popularity -- buoyant.

The result is clear: No matter how many models they wrote down and how many triumphant declarations of victory they made, the anti-Keynesians -- Lucas, Sargent and the many that followed them -- never convinced many leaders. U.S. presidents all still believe that government spending and tax rebates boost real economic output. They believe it so strongly that they’re willing to run big deficits and spend their own political capital. Only in Europe, where some countries briefly tried austerity during the Great Recession, did anti-Keynesian ideas seem to have some purchase -- and even there, policy shifted back to Keynesianism when austerity caused more harm than good.

This signals a resounding defeat for the anti-Keynesian insurgents. Yes, Nobel prizes were won, careers were made, papers were published. But an economist who can’t convince politicians has almost no power. And in the past decade or so, plenty of macroeconomists have written down models in which stimulus works just fine, and done empirical studies that back up the conclusion. The anti-Keynesians’ ideas never made it outside the walls of academia, and now they’re being challenged inside those walls as well.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Noah Smith at nsmith150@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net